1. What is the impact of lower oil prices on consumer spending? The U.S. consumer looks set to save roughly $200 billion annually1 in lower energy expenditures. The effect does operate with a lag, as the consumer buys gasoline throughout the year, saving a small amount each time. Since oil prices have fallen so precipitously, consumers have not yet had time to adjust their expectations. The full positive impact of lower prices at the pump won't be felt until consumers feel that the change is more permanent.
2. What is the impact of lower oil prices on capital spending and employment? There will be a negative impact on the oil-based part of U.S. employment and capital spending. However, these sectors are relatively small in the context of the overall economy. Energy jobs stand at 759,000 vs. a U.S. total of 140 million. Energy capital expenditures ($183 billion) equal only 1% of GDP ($17.6 trillion).2 Overall, for an economy like the U.S., which is still a net importer of petroleum, the decline in energy prices should be a net positive.
3. What's the latest on the corporate earnings outlook? While consensus 2015 S&P 500 EPS growth forecasts have fallen to 6.1% from 12.3% in October, most of the decline stems from outsized 32% negative revisions in the energy sector3. What's more, while the oil patch tends to feel the pain of lower oil prices quickly, the significant earnings benefits of oil's decline to other sectors tend to operate with a lag, suggesting the potential for positive EPS revisions in other industries as 2015 progresses.
4. Won't dollar strength negatively impact earnings growth? Given that the S&P 500 derives roughly 40% of its revenues and 33% of its earnings overseas4 dollar strength may put downward pressure on earnings through negative foreign currency translation. The good news, however, is that dollar strength is generally consistent with investors' willingness to pay a higher multiple for those earnings. The S&P 500's forward P/E has averaged a 73% monthly correlation with the U.S. Dollar Index since 2004, with December's reading at 79%5. The U.S. remains an attractive destination for investors in a world hungry for safe havens and yield, a circumstance which may only grow as the Fed ends its quantitative easing programs and the ECB and the Bank of Japan launch or rev-up their own. A stronger dollar will also put downward pressure on domestic inflation, perhaps leading the Fed to tighten more slowly. In this regard, the benefits of a strong dollar will outweigh its negatives.
5. Will the decline in commodity prices delay the Fed's plan to tighten monetary policy? The recent drop in oil prices, along with growing global deflation fears has led markets to extend the timing of the first Fed rate hike to the fall from mid-year. What's more, Chairman Yellen has made it clear that she is concerned about structural unemployment and low wage growth. As a result, we believe the Fed is likely to tighten more slowly than the consensus may currently believe.
6. With German 10-year yields at 47 basis points, what good would QE on the part of the ECB do? Two areas where QE has had observably positive impacts are in bringing inflation expectations back towards the Central Bank target, and in reducing the spread on riskier assets. Both were witnessed in the U.S. so we might expect to see the same impacts in the Eurozone as well. As with the U.S. example between 2009 and 2012, a combination of rising inflation expectations and appreciating risk assets might be the mixture of forces that eventually breaks the deflation spiral once and for all for the Euro region.
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1 Strategas Research Partners 1/16/15
2 Bureau of Economic Analysis 9/30/14. Latest data available
